Should you invest your money all at once or spread it out?

One of the questions I am most asked goes something like
this: “I have a large amount of cash to invest. Should I invest it all at once
or spread the investment out over time?” Perhaps the cash comes from the sale
of a business or an inheritance. Or the
cash might build up over time because of concerns about the market turning bearish. It might even be the
result of panicked selling.

From one perspective, the answer
appears simple. Stocks have returned about 10 percent per year, versus about 3
percent for one-month Treasury bills. The reason is that stocks are riskier
investments, and they are riskier every day. Every day you are not
invested in stocks, you are foregoing what is called the equity risk
premium, or the excess return that an individual stock or overall market provides
over a risk-free rate.

Therefore, the logical answer to the question is to
invest whenever cash is available. Doing
otherwise will likely cause an investor to eventually buy at higher and higher
prices. Unfortunately, investors don’t always base decisions on logic. In fact,
the stomach (emotions such as fear) often plays a far greater role in decision
making than the head (logic).

It is my experience that many
investors are sure that if they take the plunge and invest all at once that day
would turn out to be a high, not to be exceeded until the next millennium. This
causes them to delay the decision altogether, with often paralyzing results. If
the market rises, they feel that if they couldn’t buy at what they felt was too
high a price, how can they buy now at even higher prices? If the market falls,
they feel that they can’t buy now because the bear market they feared has now
arrived. Once a decision has been made to not buy, exactly how do you make the
decision to buy?

There
is a good solution to this dilemma, one that addresses both the logic and the
emotional issues. Investors should write a plan for their lump sum. It should
define a schedule with regularly planned investments. The following are some
suggestions:

Invest one-third immediately and the remainder
invested one-third each of the next two months or next two quarters

Invest one-quarter immediately and the remainder
spread equally over the next three quarters

Invest one-sixth each month for six months, or every
other month

The important issue is writing down and adhering to
the schedule, not the specific schedule itself. (With the new year, it’s a
great time to create a plan or to amend an existing one.) The only caveat is
that investors should not make the schedule too long, because the longer the schedule,
the more likely it is that the investor will miss out on market gains.

Once
investors have a written plan, they should sign it. If they have a financial advisor,
they should instruct him or her to implement the plan regardless of how the
market performs. This is only way an investor can be sure that the plan will be
implemented. Otherwise, the latest headlines or guru forecasts might tempt the
investor.

Having
accomplished these objectives, investors should adopt the following
perspective. If the market rises after the initial investment, they should
congratulate themselves on their wise decision. They can also feel good about
the profit. If the market has fallen, investors can congratulate themselves for
being smart enough to have avoided investing the entire amount, and they can feel
good about the opportunity to now buy at lower prices. Either way, the investor
wins from a psychological perspective. Since emotions play an important role in
how investors view outcomes, this is an important consideration.

Once investors
are convinced that a gradualist approach is the correct one, it is important to
ask themselves: “Having made your initial investment, do you want to see the
market rise or fall?” The clear logical answer is that they should root for the
market to fall so can buy more at lower prices. Aren’t we all taught to buy
low?

Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.